Whatever the Weather

How United Grain Growers tamed Mother Nature in completing the deal of the decade.

Like a farmer in the Great Depression, Peter Cox battled Mother Nature with little more than skyward eyes and mumbled hopes. Although the CFO of United Grain Growers (UGG) has never tilled an acre, he knows full well that the earnings of the Winnipeg, Manitoba-based grain handler, with $120 million in annual revenues, hang on the whims of the weather.

UGG buys grains, such as wheat and barley, and ships them for sale worldwide. Every dozen years or so, however, a drought would dry up grain production–and along with it about 20 percent of the company’s revenues. “When grain volumes fell, so did our earnings,” says Cox.

That didn’t sit well with the CFO, who was also unable to hedge UGG’s grain-volume risk, because of the diversity of weather patterns in different Canadian provinces. Consequently, Cox turned to his insurance broker, London-based Willis Corroon Corp., to formulate a solution. Together with insurer Swiss Re New Markets, they developed a first-of-its-kind insurance program that absorbs the downside of lower grain volume without taking away the upside of greater volume.

The upside for UGG has been staggering. By calming its earnings volatility, UGG has improved cash flow and increased its leverage opportunities. The insurance has also provided off-balance-sheet capital to invest in higher risk­ higher return ventures. And the cost of the policy, which blends UGG’s grain-volume risk with its myriad property/casualty exposures in a single, integrated portfolio, is comparable to what the company paid for its 20 or so separate insurance policies.

Analysts evidently are bullish on the strategy. UGG’s stock price jumped roughly $2 (Canadian) a share the day after the insurance strategy was announced last November, from about C$9 to C$11. Moreover, the strategy can benefit virtually any company–for example, a railroad whose revenues are affected by coal volume; a chemical company burdened by raw feedstock volume; or even (as an upcoming second deal will prove) a securities broker whose revenues are affected by stock exchange trading volume. Such possibilities are leading many in the industry to hail the UGG transaction, which closed on New Year’s Eve, as the deal of the decade–and the decade has just begun. “It’s a great deal,” says an executive at a competing brokerage. “I just wish it were ours.”

Quantifying Risks

It took three years to structure the UGG deal. The company went public in 1993, a year before the Toronto Stock Exchange issued the Dey Report, which recommended stricter guidelines for corporate governance–among them a requirement that boards of directors be responsible for identifying corporate risks and ensuring that processes are in place to mitigate those risks.

The Dey Report and other concerns led Cox to identify all the risks challenging UGG’s balance sheet–47 in all, from fire to foreign-exchange fluctuations. “We piled about 20 of our people into one room to develop the list,” Cox recalls. “We asked each of them to rank what they considered to be our risks in terms of severity.” In order of importance, the top six were: (1) the effect of weather on grain volume, (2) environmental risk (the company handles fertilizers and chemicals used in agricultural applications), (3) credit risk, (4) commodity price and basis risk, (5) counterparty exposure (the risk of upstream and downstream suppliers and customers not meeting contractual obligations), and (6) inventory risk.

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